Race to the bottom - now the CBA says the RBA will cut rates to 1.25%

Getty/Bruno Vincent

The Commonwealth Bank has joined the growing chorus of forecasters who now believe the Reserve Bank will need to cut rates toward 1%.

In a note overnight, CBA chief economist Michael Blythe said he now expects that the RBA “cash rate would end up at an extraordinary low of 1.25”.

That’s below current market pricing but reflects what Blythe called a “heightened level” of concern at the RBA over the projected path of inflation in Australia.

“We had pencilled in another 25bpt rate cut for August. But the level of RBA concern on disinflation and deflation risks is such is that we feel obliged to add another cut. We have inserted a further 25bpt cut in November on the usual post-CPI-Pre-SMP timing” Blythe wrote.

The new call by the CBA is the latest in a number of calls for lower rates from RBA watchers.

In a note yesterday, JP Morgan’s local chief economist, Sally Auld, said the RBA cash rate will head to 1%. Auld said she was worried about deflation and pricing power but also implied there is something amiss with aggregate demand. The “underlying shock is to firms’ pricing behaviour and their ability to pass on price rises”, Auld said.

Like Blythe, Auld is being guided by the RBA’s recent downgrades to its inflation outlook.

“The downward revisions to the RBA’s inflation rate forecasts suggest that there is now scope to run the economy harder, and labour market conditions tighter, than might have otherwise been the case,” she said.

That means we might be faced with an apparent paradox of relatively strong growth and rate cuts. But it seems the RBA is sufficiently worried about falling inflation becoming entrenched in consumer expectations (yesterday’s latest release showed expectations dropped 0.4% to 3.2%) that it will cut to forestall any chance of Australia joining Europe and Japan with persistent low inflation and growth.

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